Untangling the US Deficit
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Untangling the US Deficit

Evaluating Causes, Cures and Global Imbalances

Richard A. IIey and Mervyn K. Lewis

As the US current account deficit has expanded to a record level of $811 billion in 2006, debate about the deficit’s causes and consequences has also grown. Is the deficit a product of American profligacy or a ‘glut of savings’ in the rest of the world? Is it a serious problem or essentially benign? Untangling the US Deficit charts a course between the competing explanations in a systematic and rigorous approach, incorporating the latest academic research and market data. Particular attention is given to the China–United States trade imbalance and to the special role of the US dollar and US capital markets in global finance.
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Chapter 1: The Essence of the Problem

Richard A. IIey and Mervyn K. Lewis


THE PUZZLING DEFICIT The US current account deficit is undoubtedly one of the most significant, and at the same time puzzling, events of our age. The magnitude and significance of the US deficit seems clear. Figure 1.1 shows that from a situation of near zero in 1991, the US current account deficit in 2006 had grown to $811 billion, or 6.1 per cent of GDP, an unprecedentedly high level. It dominates global financial flows, with the world’s largest economy buying imports and other services from abroad far in excess of its exports, and financing the difference using funds borrowed from the rest of the world, including some of the poorest countries – a flow of capital described as ‘fundamentally perverse’ (Cline, 2005b, p. 2). Moreover, according to some experts the imbalance is set to widen. Forecasts by various commentators are that, with unchanged policies and exchange rates, the US current account deficit will continue to grow and range between 8–12 per cent of GDP by 2010 (Mann, 2004; Roubini and Setser, 2005; Truman, 2005). Obstfeld and Rogoff (2005) regard the US deficit ‘as a sword of Damocles hanging over the global economy’. 100 –100 –300 –500 –700 –900 1980 1 0 –1 –2 –3 –4 –5 –6 –7 1985 1990 1995 2000 2005 US current account balance, $ billion US current account balance, as a % of GDP (RHS) Sources: BEA; authors’ calculations; Reuters Ecowin Pro. Figure 1.1 US current account, 1980–2006...

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